Monday, July 16, 2012

What Central Europe thinks of Britain and why

Britain's Conservative Party is committed to repatriating powers from the EU. On July 12th, Foreign Secretary William Hague launched a review of the EU's competences. This would, he told Parliament, be an "audit of…where competence lies, how the EU's competences, whether exclusive, shared or supporting, are used, and what that means for our national interest." Many Conservatives expect this audit to prepare the ground for a manifesto commitment to renegotiate the terms of Britain's EU membership. They hope that Britain can obtain opt-outs in areas such as financial services, judicial co-operation, employment, migration, regional policy or fisheries. They argue that Britain's partners will wish to change the EU treaties to cope with the eurozone crisis, and that Britain can trade off the repatriation of powers in return for its signature.

However, any British opt-out would require the unanimous agreement of every other member-state. Conversations with diplomats from Central Europe suggest that there is very little goodwill towards London, even among its formerly stalwart allies.

The Central Europeans see the UK as an important partner. When David Cameron circulated a letter in February 2012 outlining single market reforms that would revive the European economy, five of the eleven co-signatories came from Central Europe, with Germany and France the notable absentees. The new member-states sided with London against Paris and Berlin over the Iraq war, and the UK shares their desire to bring more Balkan countries into the EU – again, against much scepticism from many continental countries.

And yet the UK cannot count on all Central Europeans to support its demand for opt-outs from EU legislation. This is for two reasons: Germany has become the central focus of the region’s foreign policies, and Britain has come to be seen by other member-states as taking advantage of the common currency's existential troubles to defend its narrow interests.

Germany is by far the largest investor in Central Europe, and its economy is deeply embedded in the wider region. When I asked a former finance minister from Central Europe to predict his country's growth rate, he replied "take Germany’s number and add one percentage point". Most Central European governments also assume that there is a possibility of the eurozone fracturing and losing some of its member-states. If and when it happens, they want to remain a part of the Berlin-led economic core. London will be of little help in such a crisis – it is too far away, has too few investments in Central Europe, and wants to have less and less to do with the EU in general. So the new member-states (and others in similar situations such as Denmark or the Netherlands) will have few reasons for wanting to spend political capital on supporting UK demands for exemptions from EU legislation, especially if Germany opposes them (and senior officials in Berlin take a hard line in opposing British attempts to repatriate powers).

Furthermore, the UK offers nothing in return (it is not contributing to the eurozone bailout fund) and Britain’s exemptions may adversely affect other countries’ economies. They fear, for example, that if the UK relaxes social protection for workers (a key Conservative demand), businesses elsewhere in Europe will migrate to the UK. "London is engaging in 'beggar-thy-neighbour' tactics", one official from Central Europe told me (though France and others say the same of the new member-states' low corporate tax rate). In December 2011 Britain threatened to veto the proposed ‘fiscal compact’ to secure an opt-out from rules governing financial services. But the tactic misfired – the rest of the EU minus the Czech Republic agreed to form the compact anyway; they did so outside existing EU treaties and without Britain. Any future banking or fiscal union will almost certainly be organised in a similar way, a Baltic diplomat told me, because the UK and the Czech Republic – and possibly others – do not want closer integration. This leaves London without any good means to pressure others to secure its opt-outs. "The rest of the EU now knows that it is possible to isolate Britain, and they are more willing than ever to do so. It is not clear that Britain realises that", the official said.

Nothing has hurt Britain's image elsewhere in Europe more than the perception that London is failing to help to end the crisis and – worse – that the UK is taking advantage of others' woes. A Polish official told me that during the December 2011 negotiations London lobbied Warsaw to stay out of the fiscal compact. Its creation is a key part of the member-states’ efforts to stop the run on their sovereign debt. The fact that Britain not only decided against joining it but sought to discourage other non-euro countries from doing so – presumably to avoid being isolated – has been seen by many as an act of remarkable ill will. According to a senior Baltic official "Britain is a nuisance; it imposes an additional burden on us of having to go around it, complicating negotiations". This is not entirely fair: British proposals on how to stimulate economic growth, which many Central European governments signed, are among the most thoughtful of such contributions. But European diplomats think that London puts a lot more energy into demanding special deals for itself than solving the crisis.

The Central European officials I interviewed sounded genuinely regretful of Britain's growing estrangement from the EU – there was no sense of 'good riddance' or gloating. But Britain’s likely demands for opt-outs from EU policies will have very little support from them (with the possible exception of the Czech Republic). A dangerous situation has emerged. Even though the government in London seems likely to attempt to unpick some of its ties, rather than sever them all, it risks rejection. And would a bruised UK want to remain in the EU? The Central Europeans fear that Britain may drop out in anger, in effect leaving the EU by accident rather than by design. But, as one Polish official acknowledged "as long as the eurozone is a mess, Britain will not want to be shackled to a sinking ship. We need to sort out our banks and economies first, thus giving London the reason to stay".

Tomas Valasek is director of foreign policy and defence at the Centre for European Reform.

Thursday, July 12, 2012

Has the eurozone reached the limits of the politically possible?

June's EU summit was the first to agree measures that address the core of the crisis: inflated government borrowing costs that weaken public finances and ultimately make sovereign insolvency self-fulfilling; and a vicious cycle in which worries about bank and sovereign solvency feed on and amplify each other. Unfortunately, the agreed measures were modest and have already prompted a backlash in various countries, not least in Germany and the Netherlands. Indeed, much of what was agreed at the summit is unlikely to come into effect. All this suggests that the limits of the politically possible may already have been reached.

Many commentators have raised the possibility of a grand bargain under which the Germans sign up to debt mutualisation and the French agree to cede sovereignty over budgetary policy. Germany has not ruled out debt mutualisation and a banking union, but argues that there must be a political union first. The problem with Germany's position is that the French have never ruled-out a loss of budgetary sovereignty in return for a proper fiscal union. Nor have the Spanish or the Italians. They are not opposed to political union, but argue that there must be crisis management first. 

This French-Italian-Spanish argument makes sense; there is not time to create a political union before acting. Also, countries cannot cede sovereignty without getting something immediate in return. For example, if Mario Monti signed up to whatever the Germans mean by political union without extracting a concrete commitment to mutualise debt, he would be out of power very quickly. If the Germans offered some form of risk mutualisation in return for much closer political integration, the French, Italians and Spanish would no doubt readily sign up. The Germans know that. The problem is not how to strike a grand bargain; the question is whether the Germans want it or are able to deliver on their part of it.

The necessary institutional reform can hardly be pushed through under the radar, but must win democratic approval. This will clearly not be easy to secure. Of course, while Germany is running a big trade surplus with the rest of the eurozone which Germany's private sector is no longer willing to finance, transfers of one sort or another are inevitable. But no-one should be under any illusions about how difficult this is for politicians to explain to their electorates, even if they understand themselves. In the public's eyes and in the minds of many politicians, a trade surplus just shows that their country is more competitive. What could be wrong with that?

And the Germans and others do have legitimate concerns about the sustainability of a fiscal union. It will require a high degree of solidarity between its component parts. We see that solidarity within Germany, or in the UK or US, but it is less clear that it exists in the eurozone. Even if they could win democratic approval for such measures, German politicians understandably fear that a fiscal union would be difficult to sustain politically. This would especially be the case if the performance of eurozone's southern members failed to improve, creating a kind of giant Mezzogiorno. German politicians fear that this could give rise to populism and anti-EU feeling. There are similar concerns in the Netherlands and elsewhere.

In short, there is a far from negligible risk that the Germans and their allies are not going to move far enough to save the euro, or that they fail to get the necessary political buy-in for whatever they do agree to. Under such a scenario the euro really could unravel. If – and it is hard to see how they can avoid it under the current policies – Spain and Italy get caught in a vicious cycle of slump and rising debt, Spanish and Italian borrowing costs will continue to rise, shutting them out of the market. The ESM is too small to bail-out them out, and there is no chance of it being granted a bank license so as to borrow unlimited sums from the ECB. The ECB itself could enter the market itself and buy large volumes of Spanish and Italian debt, but the central bank may not be able to do this in the face of staunch opposition from Germany and a number of others. Could Germany and its allies be outvoted on the ECB? This is possible. But if they were, this would put paid to the possibility of the Germans, Dutch and other sceptical countries making concessions on the institutional questions, so it could prove a pyrrhic victory.

At this point the politics would start to look decidedly dicey in the struggling economies, and between them and the core of the eurozone. Politicians may start to feel trapped. Italy could prove pivotal. With Monti gone and replaced by a more populist leader, at the head of a coalition including the new anti-euro movement led by Beppe Grillo, the Italians could threaten to quit the euro unless the costs of sharing the currency are pooled. This would be a credible threat. Italy has a primary budget surplus (that is, a surplus before the payment of interest). The Italians would be loath to play such a card, but Italy could come to perceive departure as the lesser of two evils. If Italy withdrew, so would Spain. France would then come under massive pressure. The Germans would probably offer France a debt union, but would the latter go for it? They would have a hugely overvalued currency and would be a very junior partner.

To many this scenario will sound far-fetched – how could something that will have such far-reaching implications for the European economy, the region's political stability and its security, be allowed to happen? Because the solution to the crisis requires governments to do things for which they have no mandate. And the longer the crisis festers, the more difficult it will be to win such a mandate. This is the tragedy of the eurozone's handling of the crisis. Had the ECB been allowed to intervene in the markets and dispel fears for the solvency of the Spain and Italy, and had the region's creditor countries refrained from imposing self-defeating fiscal austerity on the struggling economies, the eurozone would have had much more time to prepare the ground for the necessary institutional reforms, which could have been implemented incrementally. But the crisis has now deepened to such a point that only big institutional steps will restore the credibility of the eurozone. This puts politicians in the eurozone's creditor countries in an invidious position: save the euro and be voted out of office, or open the way for an unravelling of the single currency with all the resulting economic and political fall-out. 
Simon Tilford is chief economist at the Centre for European Reform.

Tuesday, July 10, 2012

Britain should not go Swiss

British eurosceptics want to renegotiate the UK’s relationship with the EU. They divide into two camps. There are those who want Britain to stay in the EU, but win opt-outs from social and employment legislation and from justice and home affairs policy. This includes most Conservative government ministers. A second group, which includes many Conservative backbenchers, wants a looser relationship still. This camp seeks a British withdrawal from the EU.

The second group is vaguer about the terms on which the UK would carry on its trade with continental Europe after withdrawal. Some speak of a Norwegian arrangement, which would involve the UK joining the European Economic Area (EEA). Alternatively, the UK could sign a bilateral free trade agreement, under which Britain would be free to regulate its own markets as it sees fit. For most people in this camp, EU membership burdens the UK with too many regulations. If the UK left the EU, British products would still be in high demand, and the UK could carry on trading, but free of the EU’s supposedly constraining rules. And without those rules, the UK could concentrate on chasing growing demand in Brazil, China and the rest. The UK could become Norway or Switzerland – that is, in Europe but not in the EU, and freer and more prosperous as a result.

There are three flaws in this analysis, which arise from confusion about the nature of the single market, a failure to be hard-headed about its costs and benefits, and a lazy assumption that the UK can become Norway or Switzerland.

To take the last point first: Norway and Switzerland have a semi-detached relationship with the EU. But they are more attached than some eurosceptics imagine. As a member of the European Economic Area, Norway (along with Iceland and Liechtenstein) has access to the EU’s single market, and Norwegian citizens have the right to travel and work in the EU. Norway, moreover, has opt-outs from EU policies it does not like – like the EU’s common fisheries policy. But Norway’s special arrangements come at a price: the country must implement the EU’s single market legislation – including the social policies so disliked in Britain – but is excluded from decision-making on the rules. Norway must also contribute to the EU budget for structural funds and regional development.

If Britain withdrew from the EU and joined the EEA, it would be able to opt out of the common agricultural and fisheries policies. This would save a modest amount (around £1.1 billion a year, or 0.07 per cent of GDP) because Britain pays more into these programmes than it gets out. But Westminster would still have to sign all single market legislation into law, including social and employment policies.

What about Switzerland’s arrangements with the EU? Switzerland is not in the EEA, but has negotiated a series of bilateral agreements to get access to some areas of the single market. Switzerland must largely accept EU legislation pertaining to the markets it wants access to.

But is this not precisely the relationship the eurosceptics want? Could the UK, like Switzerland, have its fondue (the ability to sell to the rest of Europe) and eat it (avoiding those Brussels directives it dislikes)? Unfortunately, the answer is no. Switzerland signed up to the EU’s customs union in 1972, which abolished subsidy and tariff barriers. Since then, it has also decided to sign up to the majority of the single market: it is a full member of the single market for goods, a signatory to the Schengen agreement, and it has signed up to most of the single market for capital. In many areas, therefore, Switzerland is effectively a member of the single market. But like Norway, it does not have the ability to affect the rules that govern it.

Swiss firms are asking for further integration, too. Switzerland decided not to sign up to a range of financial services legislation in the 2000s, and was frozen out of some EU markets as a result. Swiss fund managers were prevented from offering asset management across the EU. Swiss banks are now starting to put pressure on the government to sign up to the EU’s post-crash financial rules.

All of which brings us to what the single market is, and why the UK needs it. Among developed countries, the biggest remaining obstacles to trade are non-tariff barriers like different national regulatory regimes. Eliminating tariffs and subsidies will only get you so far: if drugs have not been licensed for sale in another country, they cannot be exported. The single market aims to eliminate non-tariff barriers to trade by establishing common minimum standards, then forcing member-states to open their markets to foreign firms.
Yes, the EU’s approach to this has created some economic costs in the form of regulation (partly to soothe workers’ fears of competition run amok). But it is hard to argue that they are particularly large: under the working time directive, people have the right not to work more than 48 hours, and if they want to work more they are allowed to do so. Meanwhile, the benefits of single market membership are enormous. In principle, British firms have access to a huge market for their products, without 27 different sets of national barriers getting in the way. And foreign firms can enter our markets, forcing domestic companies to improve their performance.

It is difficult to imagine that the rest of the EU would cheerily say goodbye to Britain, but then let it have access to the single market without keeping the rules it has already signed up to, and agreeing to sign future rules into national law. And unlike Norway, the UK is a big and diverse trader. It does not specialise in oil: the UK is a big trader in many services, including telecoms, business consultancy, software and computing, law, financial services, publishing, design and much else. It also exports many high-technology goods, especially pharmaceuticals, chemicals and photographic equipment. Common regulations in each of these sectors allow UK firms to export without adapting their products and services to meet the rules of every country. This is not to suggest that foreign imports are not also good for the UK economy. British firms that cater for domestic markets are challenged by other European firms, forcing them to be more productive and innovative. Therefore, if it left the EU, it would still be in the UK’s interest to sign up to many of the EU’s rules.

In any event, it is almost certain that Britain’s eurosceptics will not get what they want: access to the single market without having to respect the common rules that make it work, or the policing of those rules by the Commission and the Court of Justice. Britain’s partners do accept its opting out of the single currency and some justice and home affairs policy. But they will not let Britain have something for nothing.

John Springford is a research fellow at the Centre for European Reform

Friday, July 06, 2012

Are Europeans a better transatlantic security partner than meets the eye?

The latest wave of European military spending cuts is swelling the ranks of Americans who believe that Europeans are not contributing enough to global security. But this assessment is too harsh. It is true that Europeans spend less on defence than their American counterparts. They have also been less willing to use force in recent years. But the US itself is reassessing the merit of its military interventions over the last decade. And when one takes into account policies that are not strictly military, such as aid, sanctions and homeland security, Europeans are making some significant contributions to international stability.

A number of European countries are undoubtedly falling short of their NATO and EU promises to develop a global military reach. Many governments have been slow to transform their militaries from immobile forces designed to counter a Soviet invasion into rapidly deployable combat troops. Even prior to the economic crisis, most European NATO allies had stopped spending the alliance's agreed benchmark of 2 per cent of GDP on defence. And Nicolas Gros-Verheyde, the influential French blogger, estimates that the economic downturn will lead to a 30 per cent drop in total military spending by EU member-states between 2006 and 2014. As a result, even if America cuts its own defence budget by $1 trillion over the next decade – as Congress is currently considering – the US military will still receive more than twice as much as the armed forces of all EU countries combined. 

Since the end of the Cold War, a number of European countries have also been reluctant to deploy troops, particularly for heavy combat operations. Many governments have refused to send their soldiers to the most dangerous parts of Afghanistan. More than half of the European countries in NATO did not participate in the deployment to Libya. And many EU military and civilian missions have been too small to make a significant impact. Washington critics are particularly dismissive of the 60 EU officials advising Iraqis on how to improve their criminal justice system and the approximately 500 EU police trainers in Afghanistan.

Europe's recent military track record derives from the fact that most Europeans have not felt threatened. Many also do not believe that war should be used to obtain 'justice'. In a recent GMF survey of the US and 12 EU countries, only 33 per cent of Europeans believed that war is sometimes necessary to obtain justice – in contrast to 75 per cent of Americans. In addition, Europeans have been particularly doubtful of the merit of Washington's use of force over the past decade, be it Afghanistan or Iraq.

In light of this mindset, Europeans have actually been quite active on the military front. According to the Stockholm International Peace Research Institute, in 2011, Britain, France and Germany were still amongst the ten largest military spenders in the world (ranking third, fourth and eighth). The combined defence expenditure of European NATO members is still more than twice what China spends – even though Europeans do not reap the full benefits of it because they duplicate many of their military efforts. 

For several years, European troops made up more than half of NATO's mission in Afghanistan. And on a per capita basis, Denmark and Estonia have suffered more casualties there than the US. Europeans undertook 90 per cent of the strike missions in Libya. In addition, many of the EU's missions, even if modest, are still helping to stabilise countries across the world. In the Gulf of Aden, an EU naval force protects vulnerable boats from pirates, including the World Food Programme vessels which deliver food to Somali people. In the months to come, the EU will deploy civilians to help the government in Niger reform its security sector (a country where, according to European governments, Islamist militants threaten international security). EU experts will also soon help improve the security at the international airport in Juba, the capital of newly independent South Sudan.

In any case, American policy-makers are themselves reconsidering the merits of how the US has used force over the last decade. The Obama administration has been extricating US armed forces from Iraq and Afghanistan – even though in both countries, the US has not achieved the level of stability which it had initially aspired to. The government's new defence guidance stresses that the US does not intend to deploy similar missions in future. It also argues that America cannot meet its security challenges through military force alone and that it must strengthen all the 'tools' of American power, including diplomacy, development, intelligence and homeland security. 

These are areas in which Europeans are significant players. Combined, the EU institutions and member-states are the largest aid donor in the world. According to the OECD, they spent €69 billion in 2011 – notwithstanding the fact that some European countries reduced their budgets because of the economic crisis. This is more than twice the amount the US gave. Between 2002 and 2013, the EU institutions and member-states will notably have provided €11 billion in aid to Afghanistan. And in response to the Arab Spring, the EU institutions alone have offered nearly €7 billion over three years. 

Europeans also invest significant resources in homeland security, even if budgets risk declining somewhat over the next few years because of the economic turmoil. Based on the latest OECD figures, the 21 EU member-states which belong to the organisation spent nearly €240 billion on 'public order and safety' in 2010 – nearly 90 per cent of what the US spent. This covers police forces, intelligence services, the judiciary and ministries of internal affairs. The US is a beneficiary of this spending too – in addition to supporting Europe's internal stability, these bodies tackle the international terrorism and organised crime that afflict Europeans and their allies alike. 

European countries are also increasing the EU's involvement in security matters – including through the EU's bilateral ties with third countries. One EU agency, Frontex, monitors the Union's southern and eastern border, while another, Europol, tackles organised crime. EU funds for homeland security, although still modest, are increasing despite the economic crisis. From 2014 to 2020, the EU is expected to spend nearly €10 billion in this field. The money will notably fund research into intelligent maritime surveillance systems and help partner countries across the world fight criminal networks and monitor their borders more effectively.

European governments also leverage the EU's large common market to pursue their foreign policy objectives. They offer preferential trade ties to support the economic development of numerous fragile countries across the world, and to encourage them to improve their governance. Pakistan is one of the states which qualify for some of the EU's most generous trade concessions. EU countries also impose heavy sanctions on countries which they believe are undermining international security. Among other things, the EU recently introduced an oil embargo against Iran – even though the measure is inflicting significant economic hardship on Greece and other EU states which were already struggling with the financial crisis. And through the offer of EU and NATO membership, Europeans (and the US) have managed to spread stability across the European continent.

The fact that Europeans wield such extensive foreign policy 'tools' does not mean they always use them wisely. Nor should it allow Europeans to neglect their armed forces. Governments must ensure that their peacekeeping efforts are not hampered by inadequate military equipment, and that they retain the capacity to respond to a serious military threat if one were to emerge. But America is less alone in upholding global security than some in Washington would suggest.

Patryk Pawlak is a research fellow at the EU Institute for Security Studies and Clara Marina O'Donnell is a research fellow at the Centre for European Reform and a non-resident fellow at The Brookings Institution.